How Does a Roth IRA Work?

3 min read • March 11, 2019

30 sec brief

A Roth IRA is a type of retirement account. You make post-tax contributions to your account either on a monthly or yearly basis and the firm invests your money in a portfolio of stocks, bonds, mutual funds and other investments. Bottom line, the Roth IRA is only one of the investment vehicles out there that can help you save for retirement.

There are a lot of investment vehicles out there and the
sheer number of acronyms can leave you feeling lost in an alphabet soup. In this post, we’re going to break down the
Roth IRA—what it is, how it works and who it’s good for.

What is a Roth IRA?

A Roth IRA is a type of retirement account. You make post-tax contributions to your
account either on a monthly or yearly basis and the firm invests your money in a
portfolio of stocks, bonds, mutual funds and other investments.

Roth IRA Contribution Limits

The government limits the amount of money you can contribute
to a Roth IRA each year based on how much money you earned in that year.

If you’re single or the head of household, you
can make up to $121,999 per year and contribute the maximum amount of $6,000 to
your Roth IRA account ($7,000 if you’re over the age of 50). If you make between $122,000 and $136,999,
you can still contribute at a reduced rate and if you make over $137,000 per
year, you’re not eligible to contribute to a Roth IRA at all.

If you’re married and filing jointly or a
qualified widower, you can make up to $192,999 and contribute the maximum
amount of $6,000 to your Roth IRA account ($7,000 if you’re over the age of
50). If you make between $193,000 and $202,999,
you can contribute at a reduced rate and if you make $203,000 per year or more,
you can’t contribute to a Roth IRA at all.

If you’re married, filing separately, you can
only contribute to a Roth IRA if you make less than $10,000 per year, and that contribution
will be at a reduced rate.

Roth IRA Distribution Rules

Unlike other types of retirement accounts, you can withdraw
any of the contributions you’ve made to your Roth IRA tax-free and without
paying a penalty. However, if you
withdraw any earnings you’ve made before you’ve reached the age of 59 ½, you’ll
have to pay a 10% penalty as well as income tax on those earnings. Once you’re 59 ½ years of age, you can start
to withdraw your contributions and
earnings tax-free.

The great thing about Roth IRAs, is that they’re not subject
to the same required minimum distributions as other retirement accounts like
401ks. If you have a 401k, you’re
required to start taking the minimum distribution (which is determined by the
IRS based on the account size) from this account, once you’ve reached 70 ½
years of age. But with a Roth IRA, you
never have to take a distribution from the account if you don’t want to. That means your money can stay invested and
continue earning more money for as long as you want or need.

Who are Roth IRAs Good for?

Since the contribution limits favor people making below a
certain income, Roth IRAs make sense for people who are just starting out in
their careers or people who expect to have a higher tax base in the
future. The tax and penalty-free
contribution withdrawal also makes Roth IRAs great for people who want a more
investment-friendly way to save money.
You can use your contributions for a down payment on a house, schooling
or even in the case of a financial emergency.

How is a Roth IRA Different from Other Retirement Accounts?

] Other retirement accounts like 401ks and Traditional IRAs allow you to make contributions pre-tax and then when you start to withdraw from your account upon retirement, those contributions and earnings are subject to income taxes. The yearly contribution limits are higher for 401ks ($19,000 for people under 50, $25,000 for people over 50), and any distribution made before the age of 59 ½ is subject to a 10% penalty as well as income taxes. One thing you can do with a 401k that you can’t with a Roth IRA, is take out a loan of up to 50% of the account’s vested value.

Bottom line, the Roth IRA is only one of the investment
vehicles out there that can help you save for retirement. But if your annual income is at or below the
maximum allowed for maximum contribution and you want tax-free income once you
retire, or if unrestricted access to your contributions is important to you,
then it’s definitely worth considering.

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.

About the author

Lauren Hargrave is a writer from San Francisco who focuses on technology, finance and wellness. She follows comedians like most people follow bands and believes an outdoor sweat session can cure almost any bad mood. She’s also been writing her first novel for so long, her mom doesn’t ask about it anymore.